The assumption that overhead is bad does not reflect the true costs to fulfil a nonprofit’s mission. A recent article from the Chronicle of Philanthropy may rewrite this outdated overhead myth for nonprofits. Many funders and donors believe that a lower overhead rate means the organization is a better charity.
However, research from this recent article is now showing that nonprofits which “spend more on information technology, facilities, equipment, staff training, program development, and fundraising tend to be more successful than those that skimp on these ‘overhead expenses.”
What is Overhead?
Any expense that is not tied to programs is considered overhead. Overhead rates for a nonprofit can be calculated by using the information provided in IRS Form 990, Section IX, Statement of Functional Expenses. All expenses fall into one of three categories:
Program Service Expenses
Fundraising Expenses
Management and General Expenses
Overhead Rate Formula
Management and General Expenses
+ Fundraising Expenses
Divided by Total Expenses = Overhead (%) Rate
While there is not a universally accepted “good” overhead rate, several leading nonprofit authorities agree up to 40% is an acceptable range. For example, the Better Business Bureau, states that 35% is an acceptable overhead rate.
History of Overhead Myth
In 2009, Stanford Social Innovation Review published an article titled, “The Nonprofit Starvation Cycle” The article highlighted this self-defeating cycle:
Donors’ unrealistic perception of overhead costs
Pressure to conform to expectations
Nonprofits spend too little and under report their expenses
Under spending and under reporting perpetuates unrealistic expectations
Starvation Cycle
Spending too little on overhead is detrimental for a nonprofit. The Chronicle article’s research showed spending too little on overhead “deprives nonprofits of the competitive salaries, staff training equipment and other resources they need for long-term success.”
In 2013 GuideStar, Charity Navigator, and the Better Business Bureau Wise Giving Alliance wrote a letter to the Donors of America under the banner of the Overhead Myth Campaign. Quoting from their letter, “The percent of charity expenses that go to administrative and fundraising costs – commonly referred to as ‘overhead’ – is a poor measure of a charity’s performance.”
Recommended strategies for nonprofits to counter these assumptions:
Be transparent, not just with expenses but also with programs information, equity strategies, staff and client demographics, and goals.
Demonstrate how your organization is effective and efficient
Be open about the impact made by your organization with your donors.
Cheers,
Michelle Crim, CFRE
Dynamic Development Strategies can help. We offer coaching, grant writing, and fundraising services for our nonprofit clients. We specialize in small to mid-size organizations because we understand your challenges. Please contact us for more information.